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Thread: Solution to the Credit Crisis: The Return to the Gold Standard

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    Solution to the Credit Crisis: The Return to the Gold Standard

    Found this piece on Incredible Charts, which is a trading website I visit a couple of times a week. I think it is JetsCrazey who has been advocating around here for a return to the Gold Standard, but maybe it is another poster.

    Have to admit I have a 'middle of the road' attitude to the Gold Standard - I think the world would be a lot better off with it, but that it would have to be introduced incrementally. It is a similar position to that advocated by the person at Incredible Charts.

    However, while the fiat currency situation remains, there are ample opportunities to be had to make money, because of the distortions in financial systems that it creates - and that is the problem, a return to the gold standard would be against the vested interests of a lot of very, very rich people who have a lot of power.

    Anyway, here is the piece:

    What we are facing is no mere speed bump in the road to prosperity. The looming threat of credit expansion has been ignored by regulators for the past three decades and we now face a crisis of confidence in the financial system. Unfortunately the only tool that central banks have available is to lower interest rates to artificially low levels in an attempt to support falling asset prices. If they succeed, and demand for credit again expands, we are being set up for another financial collapse in the not too distant future. If they fail, we face the mother of all credit contractions and a global recession that will be remembered in a similar light to the 1930s.

    Neither alternative is very inviting, but we should hope for the former in order to buy ourselves some time. I see politicians and commentators talking about rescue packages and running off lists of what needs to be done. Most are band aid solutions that may provide some temporary respite but do not address the underlying distortions in the economy.

    Continued credit expansion will merely create further problems in the financial system. Central banks have not shown sufficient restraint to contain credit expansion. There always seems to be a crisis that requires "exceptional measures" (i.e. credit expansion). And when the crisis is over the credit expansion remains, possibly due to political pressure.

    The underlying cause is the fiat monetary system. Fiat currency is paper money that is not backed by anything other than a promise to pay by the central government. In effect it is an IOU from the Treasury.

    Every past attempt at a fiat currency has collapsed due to a lack of restraint by the issuers — and this time is proving no different. Since August 1971, when Richard Nixon acknowledged that the US government could not honor its commitments, by abandoning the gold standard, we have experienced rampant credit expansion and inflation. While the Bretton Woods gold standard, where foreign central banks could exchange $35 for an ounce of gold, was a far from perfect system, it did place some constraint on money and credit expansion. After that, the printing presses ran hot apart from a brief period under Paul Volcker. Official inflation figures allayed our fears, suggesting that the new monetary system was under control and the "miracle workers" at the Fed could create prosperity out of thin air.

    Today we have to exchange $900 for an ounce of gold. That works out at an annual inflation rate of 9 percent since 1971. This may be a slight overstatement as the printing presses were already running prior to abandonment of the gold standard — and $35 per ounce may already have been unsustainable from the mid-1960s. But if we go back as far as 1960, this still works out at an average inflation rate of 7 percent. Makes you wonder how many bondholders have made a real return on their investment in recent years.

    The Founders of the US Constitution had experienced the disastrous effects of a fiat currency before — when the Revolutionary War was financed by government-issued Continental Currency. Repeated issues gradually debased the currency to the point that the phrase "not worth a Continental" became part of our common language. In an attempt to prevent a repetition, the Constitution made only gold and silver legal tender and forbade the issue of "bills of credit" — what we now refer to as paper money.

    To this day, Treasury is prevented from issuing paper money. Unfortunately, financial engineers in the early 20th century found a loophole with which banks today are all-too-familiar: they created an SIV (structured investment vehicle). While the Federal Reserve has an eagle on its crest and an official-sounding name it is not part of the federal government. It may be subject to regulation by Congress, but its stocks are held by the various member banks. That is why, when the Fed issues dollars, they are "Federal Reserve Notes" presentable to the federal reserve banks — and not the federal government, which would be a breach of the Constitution.

    I am not advocating abolition of the Federal Reserve, nor immediate re-introduction of the gold standard, which would be too radical a step to have any chance of success. But additional constraints are necessary to prevent further credit creation, including replacing the Fed policy objective with a simple instruction to "protect the value of the currency". The current objective is merely a euphimism for "quietly debase the currency to keep the voters happy". Further measures should include abolition of SIVs (except for the Fed), strict enforcement of conservative (1 to 10) capital-asset ratios, and limits on credit expansion to conform to projected real growth in GDP. Hopefully after a few decades the financial system will have stabilized to the point that we can consider a return to the gold standard — as this is the only standard that has stood the test of time.

    [URL="http://www.incrediblecharts.com/tradingdiary/trading_diary.php"]link[/URL]

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    Can you explain the gold standard to me?

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    For the first time in my life I actually bought gold in my portfolio back at the end of September. Right around the time the numbskulls in DC were kicking around the bailout idea like a bunch of uncoordinated buffoons, I just said it can't hurt to buy a little GLD and just tuck it away and forget about it. Everyone knows about owning stocks vs. bonds but owning an interest in some actual hard assets is never really a bad thing.

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    [QUOTE=Roger Vick;2799029]Can you explain the gold standard to me?[/QUOTE]

    Sorry mate, very time poor at the moment - do a wikipedia and you'll find what you're after, else I'm sure JetsCrazey or whoever it is will jump on this thread at some stage.

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    [QUOTE=Roger Vick;2799029]Can you explain the gold standard to me?[/QUOTE]

    [url]http://en.wikipedia.org/wiki/Gold_standard[/url]

    The gold standard is a monetary system in which a region's common media of exchange are paper notes that are normally freely convertible into pre-set, fixed quantities of gold. The gold standard is not currently used by any government, having been replaced completely by fiat currency, and private currencies backed by gold are rare.

    Gold standards should not be confused with their historical predecessor, "gold-coin standards", wherein taxes are payable in either gold coins or overvalued, government-minted, less expensive, coins.

    The main purpose of either government money system has historically been to provide seigniorage, or money-creation profit, to governmental leaders in order to provide them with general purchasing power during emergencies, especially those leaders who are legislatively constrained and therefore unable to raise taxes in order to execute the defense commitments that are required for the survival of their states (Thompson, 1974.)

    Gold standards replaced gold-coin standards in the 17th-19th centuries in the West as the extent of defensive warfare expanded to where the gold-coin standards were no longer sufficient to the task. A similar history generated a gold standard in China from the 9th through the early 17th century.

    .....(continued)

    [B]Advantages[/B]

    The history of money consists of three phases: commodity money, in which actual valuable objects are bartered; then representative money, in which paper notes (often called 'certificates') are used to represent real commodities stored elsewhere; and finally fiat money, in which paper notes are backed only by use of' "lawful force and legal tender laws" of the government, in particular by its acceptability for payments of debts to the government (usually taxes).

    Commodity money is inconvenient to store and transport and is subject to hoarding.[3] It also does not allow the government to control or regulate the flow of commerce within their dominion with the same ease that a standardized currency does. As such, commodity money gave way to representative money, and gold and other specie were retained as its backing.

    Gold was a common form of representative money due to its rarity, durability, divisibility, fungibility, and ease of identification,[4] often in conjunction with silver. Silver was typically the main circulating medium, with gold as the metal of monetary reserve.

    The Gold Standard variously specified how the gold backing would be implemented, including the amount of specie per currency unit. The currency itself is just paper and so has no innate value, but is accepted by traders because it can be redeemed any time for the equivalent specie. A US silver certificate, for example, could be redeemed for an actual piece of silver.

    Representative money and the Gold Standard protect citizens from hyperinflation and other abuses of monetary policy, as were seen in some countries during the Great Depression. However, they were not without their problems and critics, and so were partially abandoned via the international adoption of the Bretton Woods System. That system eventually collapsed in 1971, at which time all nations had switched to full fiat money.

    Former US Federal Reserve Chairman Alan Greenspan once argued, before the advent of monetarism, that

    "under the gold standard, a free banking system stands as the protector of an economy's stability and balanced growth... The abandonment of the gold standard made it possible for the welfare statists to use the banking system as a means to an unlimited expansion of credit... In the absence of the gold standard, there is no way to protect savings from confiscation through inflation."[5]
    Last edited by jetstream23; 10-11-2008 at 05:13 AM.

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    [QUOTE=Black Death;2799013]Solution to the Credit Crisis: The Return to the Gold Standard [/QUOTE]

    Great article and a good site. I just subscribed to their monthly newsletter. Thanks.

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    [QUOTE=jetstream23;2799077]Great article and a good site. I just subscribed to their monthly newsletter. Thanks.[/QUOTE]

    No worries, mate. Was it you who was posting about the gold standard a fair while back? Might have got you mixed up with JetsCrazey for some reason.

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    [QUOTE=Black Death;2799085]No worries, mate. Was it you who was posting about the gold standard a fair while back? Might have got you mixed up with JetsCrazey for some reason.[/QUOTE]

    Not me. I've been all over the current economic and market problems for months now but I haven't talked about the Gold Standard. Good article.

    It's interesting that Britain's return to the Gold Standard was cited as one possible reason for the economic troubles of 1929 turning into a deep depression. I just started a thread looking back at The Great Depression....not because I think we're going there but because those who forget history are destined to repeat it. :(

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    [QUOTE=jetstream23;2799089]Not me. I've been all over the current economic and market problems for months now but I haven't talked about the Gold Standard. Good article.

    It's interesting that Britain's return to the Gold Standard was cited as one possible reason for the economic troubles of 1929 turning into a deep depression. I just started a thread looking back at The Great Depression....not because I think we're going there but because those who forget history are destined to repeat it. :([/QUOTE]

    Romer's paper for the Great depression is a must read for those advocating a return to a gold standard. (As in, inflexible fixed exchange rates were a major cause of the Depression) I'd highly suggest people read it. It's long, but it's an incredibly good read. Here is a part of it:


    [QUOTE=Christina Romer;2799089][B]The gold standard[/B]
    Some economists believe that the Federal Reserve allowed or caused the huge declines in
    the American money supply partly to preserve the gold standard. Under the gold standard, each
    country set a value of its currency in terms of gold and took monetary actions to defend the fixed
    price. It is possible that had the Federal Reserve expanded greatly in response to the banking
    panics, foreigners could have lost confidence in the United States’ commitment to the gold
    standard. This could have led to large gold outflows and the United States could have been
    forced to devalue. Likewise, had the Federal Reserve not tightened in the fall of 1931, it is
    possible that there would have been a speculative attack on the dollar and the Unites States
    would have been forced to abandon the gold standard along with Great Britain.
    While there is debate about the role the gold standard played in limiting U.S. monetary
    policy, there is no question that it was a key factor in the transmission of the American decline to
    the rest of the world. Under the gold standard, imbalances in trade or asset flows gave rise to
    Page 5
    international gold flows. For example, in the mid-1920s intense international demand for
    American assets such as stocks and bonds brought large inflows of gold to the United States.
    Likewise, a decision by France after World War I to return to the gold standard with an
    undervalued franc led to trade surpluses and substantial gold inflows. (Τ balance of trade.)
    Britain chose to return to the gold standard after World War I at the prewar parity.
    Wartime inflation, however, implied that the pound was overvalued, and this overvaluation led to
    trade deficits and substantial gold outflows after 1925. To stem the gold outflow, the Bank of
    England raised interest rates substantially. High interest rates depressed British spending and led
    to high unemployment in Great Britain throughout the second half of the 1920s.
    Once the U.S. economy began to contract severely, the tendency for gold to flow out of
    other countries and toward the United States intensified. This took place because deflation in the
    United States made American goods particularly desirable to foreigners, while low income
    reduced American demand for foreign products. To counteract the resulting tendency toward an
    American trade surplus and foreign gold outflows, central banks throughout the world raised
    interest rates. Maintaining the international gold standard, in essence, required a massive
    monetary contraction throughout the world to match the one occurring in the United States. The
    result was a decline in output and prices in countries throughout the world that also nearly
    matched the downturn in the United States.
    Financial crises and banking panics occurred in a number of countries besides the United
    States. In May 1931 payment difficulties at the Creditanstalt, Austria’s largest bank, set off a
    string of financial crises that enveloped much of Europe and were a key factor forcing Britain to
    abandon the gold standard. Among the countries hardest hit by bank failures and volatile
    financial markets were Austria, Germany, and Hungary. These widespread banking crises could
    have been the result of poor regulation and other local factors, or simple contagion from one
    country to another. In addition, the gold standard, by forcing countries to deflate along with the
    United States, reduced the value of banks’ collateral and made them more vulnerable to runs. As
    in the United States, banking panics and other financial market disruptions further depressed
    output and prices in a number of countries[/QUOTE]

    Essentially, speculative attacks coupled with the inability to let the devalueation of gold can lead to big problems. There is a reason why we left the gold standard...unless someone can prove they know how to prevent speculative attacks it's not a good idea.
    Last edited by Jets Voice of Reason; 10-11-2008 at 12:19 PM.

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    [QUOTE=Jets Voice of Reason;2799211]Romer's paper for the Great depression is a must read for those advocating a return to a gold standard. (As in, inflexible fixed exchange rates were a major cause of the Depression) I'd highly suggest people read it. It's long, but it's an incredibly good read. Here is a part of it:

    [B]Essentially, speculative attacks coupled with the inability to let the devalueation of gold can lead to big problems. There is a reason why we left the gold standard...unless someone can prove they know how to prevent speculative attacks it's not a good idea[/B].[/QUOTE]

    The reason we left the gold standard is because it benefits the government and the banks. The banks can put more people into debt and the government can secretly tax through inflation.

    In layman's terms:
    [QUOTE]
    Return to the gold standard, not a bailout, will cure the nation's economic ills
    [url]http://www.opednews.com/articles/Return-to-the-gold-standar-by-Peter-Duveen-080927-697.html[/url]
    PETER’S NEW YORK, Sept. 27, 2008—

    As Congress considers a bailout package to stave off the collapse of the American financial system, it might do well to remember that it was legislation it passed some 40 years ago that led to the current crisis. In 1965 and 1968, during the administration of President Lyndon Johnson, Congress voted in two stages to remove the reserve requirements for Federal Reserve notes. These requirements were that for every note issued, there had to be 25 percent of its value in gold held in reserve. At the same time, the value of the dollar was maintained at $35 for an ounce of gold. These restraints put some definite limits on what the Federal Reserve was able to do. If it wanted to issue more currency, it had to bolster the nation’s gold reserves. After Congress removed gold reserve requirements, the Fed had no limits on the amount of currency it could issue. This was truly the end of the dollar as a stable monetary unit. Nixon's abandonment of a fixed parity between gold and the dollar in 1971 was a direct result of the lifting of reserve requirements, even though Nixon is often blamed for a situation not of his own making. The removal of reserve requirements paved a very bumpy road that has led to the present economic debacle. The solution is not a bailout, however, but a return to the gold standard. It is not a matter of nostalgia for the good old days. It is a call for a return to a stable and honest monetary regime. Fiat currency such as is issued by the Fed does not behave well as money. It has liabilities that are not curable. We are reaping the results of these liabilities. One of them is that it cannot supply enough money to the economy, because the monetary base is continually revalued downward. This is what we call inflation, or—what is merely the other side of the same coin—monetary contraction. Pundits have continually derided the gold standard over the past 30 or 40 years. But a commodity standard such as the gold standard is remarkable in that it allows the monetary base to expand while keeping the purchasing power of the monetary unit stable. It is these two characteristics that make a commodity standard such as the gold standard attractive, and, in fact, indispensible to a well-functioning economy. How do we get back to a gold standard? It's easy. Go to the corner store, offer the proprietor to buy something with gold, and see what he charges you. When you have completed the transaction, you and the proprietor are on the gold standard. When this practice expands, a more universal gold standard comes into being. Money is really only a convenient form of barter, and can never be more or less than that. The use of gold for this streamlined barter system is a natural choice because of its various properties. Bank notes, on the other hand, carry with them an additional element of risk that is often unstated, but very real. They are mere promises to pay, and the promise is often not kept. [B]The difference between gold and a bank note is the difference between a well-functioning monetary system and a scam, and a scam is what our country has labored under since the removal of gold reserve requirements in the 1960s.[/B] Don't worry about the bailout. The only cure for our ailing economy is a return to the gold standard. It could happen today. [/QUOTE]

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    Austrian economists no longer support the gold standard, because by "gold standard" it is implied that the government is legally fixing the price of gold (a very anti-libertarian concept).

    The new thing among Austrians is "private competing currencies"

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    [IMG]http://www.chicagoboyz.net/blogfiles/pirate-small.jpg[/IMG]

    ARRRGH! Gold, ye matey...Gold and spiced rum futures. Shivers me portfolio, Edwards Jones lockers and such...

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    A return to the gold standard is actually a really stupid idea, and the vast majority of economists know that. Here's one quick piece as to why...

    What is The Gold Standard?
    By Tarik Abdel-Monem

    The gold standard is a system in which international currencies are tied to a specific amount of gold. At the turn of the 20th century, many major trading nations used the gold standard to adjust their monetary supply. However, it was later abandoned in favor of Keynesian theories. Today, some commentators still advocate a return to the gold standard, but an examination of history would not support them.

    The Gold Standard in Theory

    The foundation of the gold standard is that a currency's value is supported by some weight in gold. Inherently, it makes sense to value currency by some tangible and precious resource, otherwise, currency is just paper bills. Therefore, by tying paper money to an amount of gold, it gives the holder of the paper money the right to exchange her paper bills for actual gold. Ideally, this requires that paper money be readily exchangeable for gold. If a bank does not have gold, then the paper money has no value. But theoretically, actual gold would flow between nations to ensure that all currencies would be supported by gold.

    A pure gold standard was used between the 1879 and 1914 by many modern trading nations. Under the gold standard system, all participating currencies were convertible based on its gold value. For example, if currency x was equal to 100 grains of gold, and currency y was equal to 50 grains of gold, then 1 x was equal to 2 y.

    Because currencies were convertible in gold, then nations could ship gold among themselves to adjust their "balance of payments." In theory, all nations should have an optimal balance of payments of zero, i.e. they should not have either a trade deficit or trade surplus. For example, in a bilateral trade relationship between Australia and Brazil, if Brazil had a trade deficit with Australia, then Brazil could pay Australia gold. Now that Australia had more gold, it could issue more paper money since it now had a greater supply of gold to support new bills. With an increase of paper bills in the Australian economy, inflation, i.e. a rise in prices due to an overabundance of money, would occur. The rise in prices would subsequently lead to a drop in exports, because Brazil would not want to buy the more expensive Australian goods. Subsequently, Australia would then return to a zero balance of payments because its trade surplus would disappear. Likewise, when gold leaves Brazil, the price of its goods should decline, making them more attractive for Australia. As a result, Brazil would experience an increase in exports until its balance of payments reached zero. Therefore, the gold standard would ideally create a natural balancing effect to stabilize the money supply of participating nations.

    The Gold Standard in Operation

    However, the operation of the gold standard in reality caused many problems. When gold left a nation, the ideal balancing effect would not occur immediately. Instead, recessions and unemployment would often occur. This was because nations with a balance of payments deficit often neglected to take appropriate measures to stimulate economic growth. Instead of altering tax rates or increasing expenditures - measures which should stimulate growth - governments opted to not interfere with their nations' economies. Thus, trade deficits would persist, resulting in chronic recessions and unemployment.

    With the outbreak of the first world war in 1914, the international trading system broke down and nations valued their currencies by fiat instead, i.e. governments took their currencies off the gold standard and simply dictated the value of their money. Following the war, some nations attempted to reinstate the gold standard at pre-war rates, but drastic changes in the global economy made such attempts futile. Britain, which had previously been the world's financial leader, reinstated the pound at its pre-war gold value, but because its economy was much weaker, the pound was overvalued by approximately 10%. Consequently, gold swept out of Britain, and the public was left with valueless notes, creating a surge in unemployment. By the time of the second world war, the inherent problems of the gold standard became apparent to governments and economists alike.

    Following the second world war, the International Monetary Fund replaced the gold standard as a means for nations to address balance of payments problems with what became a "gold-exchange" standard. Currencies would be exchangeable not in gold but in the predominant post-war currencies of the allied nations: British sterling, or more importantly, the U.S. dollar. Under the new International Monetary Fund approach, governments had a more pronounced role in managing their economies. Ideally, governments would hold dollars in "reserve." If an economy needed an influx of money because of a balance of payments deficit, the government could exchange its reserve dollars for its own currency, and then inject this money into its economy. The dollar would ideally remain stable since the U.S. government agreed to exchange dollars for gold at a price of $35 an ounce. Thus, world currencies were officially off the gold standard. However, they were exchangeable for dollars. Because dollars were still exchangeable for gold, the "gold-exchange" standard became the prevailing monetary exchange system for many years.

    The effect of the gold-exchange system was to make the United States the center for international currency exchange. However, due to the inflationary effects of the Vietnam War and the resurgence of other economies, the United States could no longer comply with its obligation to exchange dollars for gold. Its own gold supply was rapidly declining. In 1971, President Richard Nixon removed the dollar from gold, ending the predominance of gold in the international monetary system.

    Conclusion

    In retrospect, the gold standard had many weaknesses. Its foremost problem was that its theoretical balancing effect rarely worked in reality. A much more efficient means to resolve balance of payments problems is through government intervention in their economies and the exchange of reserve currencies. Today, very few commentators propose a return to the gold standard.

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    [QUOTE=long island leprechaun;2803406]A return to the gold standard is actually a really stupid idea, and the vast majority of economists know that. Here's one quick piece as to why...

    What is The Gold Standard?
    By Tarik Abdel-Monem

    [/QUOTE]

    right, like I would read anything written by someone with the name Tarik Abdel-Monem....you must hate America.:P

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    [QUOTE=long island leprechaun;2803406]A return to the gold standard is actually a really stupid idea, and the vast majority of economists know that. Here's one quick piece as to why...

    What is The Gold Standard?
    By Tarik Abdel-Monem

    The gold standard is a system in which international currencies are tied to a specific amount of gold. At the turn of the 20th century, many major trading nations used the gold standard to adjust their monetary supply. However, it was later abandoned in favor of Keynesian theories. Today, some commentators still advocate a return to the gold standard, but an examination of history would not support them.

    The Gold Standard in Theory

    The foundation of the gold standard is that a currency's value is supported by some weight in gold. Inherently, it makes sense to value currency by some tangible and precious resource, otherwise, currency is just paper bills. Therefore, by tying paper money to an amount of gold, it gives the holder of the paper money the right to exchange her paper bills for actual gold. Ideally, this requires that paper money be readily exchangeable for gold. If a bank does not have gold, then the paper money has no value. But theoretically, actual gold would flow between nations to ensure that all currencies would be supported by gold.

    A pure gold standard was used between the 1879 and 1914 by many modern trading nations. Under the gold standard system, all participating currencies were convertible based on its gold value. For example, if currency x was equal to 100 grains of gold, and currency y was equal to 50 grains of gold, then 1 x was equal to 2 y.

    Because currencies were convertible in gold, then nations could ship gold among themselves to adjust their "balance of payments." In theory, all nations should have an optimal balance of payments of zero, i.e. they should not have either a trade deficit or trade surplus. For example, in a bilateral trade relationship between Australia and Brazil, if Brazil had a trade deficit with Australia, then Brazil could pay Australia gold. Now that Australia had more gold, it could issue more paper money since it now had a greater supply of gold to support new bills. With an increase of paper bills in the Australian economy, inflation, i.e. a rise in prices due to an overabundance of money, would occur. The rise in prices would subsequently lead to a drop in exports, because Brazil would not want to buy the more expensive Australian goods. Subsequently, Australia would then return to a zero balance of payments because its trade surplus would disappear. Likewise, when gold leaves Brazil, the price of its goods should decline, making them more attractive for Australia. As a result, Brazil would experience an increase in exports until its balance of payments reached zero. Therefore, the gold standard would ideally create a natural balancing effect to stabilize the money supply of participating nations.

    The Gold Standard in Operation

    However, the operation of the gold standard in reality caused many problems. When gold left a nation, the ideal balancing effect would not occur immediately. Instead, recessions and unemployment would often occur. This was because nations with a balance of payments deficit often neglected to take appropriate measures to stimulate economic growth. Instead of altering tax rates or increasing expenditures - measures which should stimulate growth - governments opted to not interfere with their nations' economies. Thus, trade deficits would persist, resulting in chronic recessions and unemployment.

    With the outbreak of the first world war in 1914, the international trading system broke down and nations valued their currencies by fiat instead, i.e. governments took their currencies off the gold standard and simply dictated the value of their money. Following the war, some nations attempted to reinstate the gold standard at pre-war rates, but drastic changes in the global economy made such attempts futile. Britain, which had previously been the world's financial leader, reinstated the pound at its pre-war gold value, but because its economy was much weaker, the pound was overvalued by approximately 10%. Consequently, gold swept out of Britain, and the public was left with valueless notes, creating a surge in unemployment. By the time of the second world war, the inherent problems of the gold standard became apparent to governments and economists alike.

    Following the second world war, the International Monetary Fund replaced the gold standard as a means for nations to address balance of payments problems with what became a "gold-exchange" standard. Currencies would be exchangeable not in gold but in the predominant post-war currencies of the allied nations: British sterling, or more importantly, the U.S. dollar. Under the new International Monetary Fund approach, governments had a more pronounced role in managing their economies. Ideally, governments would hold dollars in "reserve." If an economy needed an influx of money because of a balance of payments deficit, the government could exchange its reserve dollars for its own currency, and then inject this money into its economy. The dollar would ideally remain stable since the U.S. government agreed to exchange dollars for gold at a price of $35 an ounce. Thus, world currencies were officially off the gold standard. However, they were exchangeable for dollars. Because dollars were still exchangeable for gold, the "gold-exchange" standard became the prevailing monetary exchange system for many years.

    The effect of the gold-exchange system was to make the United States the center for international currency exchange. However, due to the inflationary effects of the Vietnam War and the resurgence of other economies, the United States could no longer comply with its obligation to exchange dollars for gold. Its own gold supply was rapidly declining. In 1971, President Richard Nixon removed the dollar from gold, ending the predominance of gold in the international monetary system.

    Conclusion

    In retrospect, the gold standard had many weaknesses. Its foremost problem was that its theoretical balancing effect rarely worked in reality. A much more efficient means to resolve balance of payments problems is through government intervention in their economies and the exchange of reserve currencies. Today, very few commentators propose a return to the gold standard.[/QUOTE]


    Standard mainstream economic response of the variety that has seen as reach this mess we are currently in. The problem with fiat currency is the type of debt bubbles that is unspooling before our very eyes - and believe you me, the US Fed and US government will not stop the unspooling process no matter how much electronic money they create to stop the gaps.

    BTW, I think the US Fed, and the US government is completely insane. COMPLETELY BONKERS. If a criminal mastermind wanted to bring America low he couldn't have come up with a better plan. Out of this the US $ will be ripped completely to shreds - Robert Mugabe would be proud of the type of dollar devaluation that will eventuate in time.

  16. #16
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    This piece also struck me as having some very worthwhile solutions to future speculative bubbles, especially in regards to real estate:

    [B]The Panic of 2008[/B]

    Published in October 11th, 2008 Posted by Steve Keen

    This week, financial markets truly succumbed to The Panic. The US Dow Jones and S&P500 Indices lost 21%; Australia’s All Ordinaries fell 16%. “Buy and Hold” gave way to “Get Out At All Costs”.

    When we look back with the eyes of history, the ninth day of the tenth month of 2008 will be the Black Thursday on which the world’s biggest ever speculative bubble finally burst.

    Friday’s wild gyrations on Wall Street–which saw the Dow down as much as 700 points and up as much as 140, before closing down 128 points for another 1.5% loss on the day–are aftershocks from a financial earthquake driven by tectonic shifts that have a long, long way to go.

    The US markets are down 21% for this week alone, and 45% from their peak; the Australian market has fallen 16% this week, and 42% from its peak. The only other stock market crash that compares with this is, of course, 1929.

    The fall in 1929 itself was much more sudden–the fall from the market peak of 381 to Black Tuesday’s plunge to 230 points took just over a month, versus over a year this time. But the long grind to the bottom in the 1930s took three years (and the market didn’t revisit its 1929 peak until 1957). We may well face as long a wait before a new world financial order is established.

    If we can gain our senses this time, we may be able to establish a financial system that serves capitalism rather than subverts it. We need, as Hyman Minsky argued, a good financial society in which the tendency of markets to indulge in speculative behavior is constrained.

    It is obvious now that this will not be a deregulated market. But can it merely be a regulated one? Will regulations alone–bans on short selling, “Chinese Walls” between investment and merchant banking, quantitative regulation of lenders, etc.–be enough?

    Clearly they were not this time round. That is the world constructed after the Great Depression (and its political aftermath, the Second World War) when Keynes ruled economics. It fell apart over time because, as Minsky put it, “stability is destabilizing”. A period of economic tranquility ushered in by drastic reductions in debt levels and firm regulation of financial markets leads us to forget the tragedies of The Bust, and to believe that markets are inherently stable.

    This delusion was aided and abetted by the economics profession, which reacted to Keynes’s arguments about the inherent instability of markets like an immune system repelling a virus

    Economics dreamt up such absurd notions as the “Efficient Markets Hypothesis” (which assumes that markets accurately predict future earnings and value shares on that basis), the Modigliani-Miller Hypothesis (that the most rational funding model for firms is 100% debt if interest payments are tax-deductible), and Rational Expectations (markets are always in long run general equilibrium, and government is impotent to affect real economic activity), and even invented asset market valuation concepts (such as the Black-Scholes Options Pricing Model) that were integral to the development of the derivatives market, the most destabilising force of all in modern capitalism.

    Capitalism will survive this crisis, as it survived 1929; and it will be reformed, as was the sober post-WWII system after its profligate predecessor of the Roaring Twenties. But with speculation on assets still a potential path to individual riches–and with a drastically lower level of gearing, as the Great Depression level of debt unwound from its 215% of GDP peak in 1932 to a mere 45% at the start of 1945–the seeds for today’s repeat of the tragedy of speculation were sown.

    We need instead to consider redesigning the financial system so that the currently inherent profitability of leveraged speculation on asset prices (when debt levels are low) is constrained.

    I propose three such reforms, in full knowledge that they have Buckley’s of being implemented now–but hopefully they will be considered more seriously when this crisis reaches its second or third birthday.

    These are:

    To redefine shares so that, as do corporate bonds, they have a defined expiry date at which time the issuing company repurchases them at their issue price;
    To impose “caveat emptor” on mortgage agreements, so that the lender’s security is limited if poor credit evaluations were done of the borrower’s capacity to meet the payment commitments in the contract (this will be further explained below); and
    To base house price valuations on a multiple of the imputed yearly rental of a property, rather than its potential resale price.

    The intention of the first redefinition of capital assets (this is much more than a mere reform) is to put some effective ceiling on how high a share price can be expected to go, and to therefore force valuations to be based more on soberly estimated future earnings (of the sort Warren Buffett now does) than on the prospects of selling a share to a Greater Fool–which is the real basis of modern-day valuations.

    The intention of the second, which may look paradoxical, is to impose the risk of reckless lending on the lender. Note that a sale of a house by the lender is called a MortgagEE sale–where the suffix indicates that the BUYER is selling the house. The borrower, on the other hand, is known as the MortgagOR–where the suffix indicates that the borrower is the SELLER.

    What’s going on? Simple: in a mortgage contract, the lender BUYS a promise by the borrower to provide a stream of payments in the future in return for a sum of money now. The lender is the buyer.

    What if the lender didn’t properly check the capacity of the borrower to meet this commitment? If we imposed the old Common Law principle of caveat emptor–”Buyer Beware”–the consequences would fall on the buyer. At the moment, lenders avoid the consequences of poor research into a borrower’s capacity to meet the payments by getting absolute security over the asset the borrower subsequently purchased with the lender’s payment.

    Were caveat emptor imposed by the courts, I think that lenders would be rather less willing to indulge in the frenzy of irresponsible lending that has marked the end of this long speculative bubble.

    The intention of the third reform is to base lending for house purchases on the income-generating capacity of the asset being bought, rather than as now on the resale price potential. If a multiple of, for example, ten times annual imputed rental income were the basis of valuation, then it would be more than possible for a landlord to borrow money to buy a property, and rent that property out at a profit.

    This would establish a firm link between the valuation of a house, its rental income, and the maximum loan one could secure to buy it. It would forge a link between an assets valuation and its income earning potential–a link that is so fragile in today’s speculation driven market. It would also establish a class of wealthy agents–landlords–who have vested interest in keeping house prices and loan levels low.

    With such reforms, there is at least some prospect that I will not have a successor writing of the follies of the Stock Market and Housing Market Bubbles of 2060. Without them or similarly effective structural alterations, with merely regulations as were imposed after the Great Depression, we will be here again some time in the future.

    All that is, of course, for the future. The immediate problem is what to do now, if, as so many more expect than once did, this market crash is the prelude to the world’s second Great Depression.

  17. #17
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    maybe im misunderstanding the situation

    but if there isn't enough gold in the world to back the money that's out there what happens when we go to the gold standard? does certain wealth just dissapear? which wealth?

    the whole thing strikes me as bad idea jeans

  18. #18
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    [QUOTE=bitonti;2804310]maybe im misunderstanding the situation

    but if there isn't enough gold in the world to back the money that's out there what happens when we go to the gold standard? does certain wealth just dissapear? which wealth?

    the whole thing strikes me as bad idea jeans[/QUOTE]

    What it stops is central banks just printing money any time they feel like - what it stops are speculative bubbles of the type that led to the Great Depression and will lead to the second Great Depression which isn't that far away at all. What it stops, in a very real sense, is inflation.

    There are hundreds of trillions of dollars that have been created out of thin air by the fiat currency system - the whole thing in a very real sense is a house of cards that has grown in size for nearly 3 decades. The panic we have seen in the last few weeks has been very much caused by the US Fed operating within the mandates and demands of a fiat currency system. It is this system that will lead to more booms and busts further down the track - with illusory wealth being created in the boom and that supposed wealth ground into dust during the bust.

    Would I erradicate a lot of the world's wealth if I had the chance to introduce a gold standard? Goddamn right I would! At a stroke! All that speculative wealth that doesn't build real prosperity because it doesn't actually invest in things that give an actual return.

    It would be better to do it with the introduction of a gold standard than to have it taken away much more savagely as has happened across the globe in recent weeks......

  19. #19
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    Black Death, all you are doing is railing on the fiat money system which obviously has its drawbacks. Start talking about how this system is vastly different from the Gold Standard that crippled our economy in the First Great Depression.

    Honestly, you are talking as if the Gold Standard is a panacea for the economy. When it in itself brings another set of problems to the table. Of course the advantage to a fixed exchange rate is to be able to control inflation. That's the advantage. The disadvantage is the pattern of events set off that is quite indefensible and leads to economies constantly having to contract money supply to fend off attacks. Leading to a recession.

  20. #20
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    I'll admit that I always found economics boring. Don't you need to have enough gold to cover your GNP? I would think that's impossible now... :confused:

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